Impact Investing’s ‘Third Phase’: What New Challenges Lie Ahead?

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Impact investing pioneer Antony Bugg-Levine and IIX's Durreen Shahnaz discuss the road ahead for this movement.

A dozen years have passed since the term “impact investing” was coined at a meeting of investors, entrepreneurs and philanthropists at the Rockefeller Foundation’s retreat center in the Italian seaside town of Bellagio.

Antony Bugg-Levine, who was then managing director at the Rockefeller Foundation, recalled that the new term helped create a way for profit-oriented businesses to justify investments to address social problems such as poverty or inequality. Businesses began to understand how they stand to gain from a fairer society, he said. Bugg-Levine is currently CEO of the Nonprofit Finance Fund in New York, which provides loan financing, access to capital and direct advisory services to nonprofits.

Since then, the impact investing movement has overcome many challenges. However, more obstacles lie ahead even as there is untapped potential for growth, said Durreen Shahnaz, founder and CEO of the Impact Investment Exchange (IIX) in Singapore, a social stock exchange and the world’s largest impact investment private placement platform. As it happens, Bugg-Levine had encouraged Shahnaz to set up IIX at the Bellagio meeting in 2007.

Bugg-Levine and Shahnaz tracked the accomplishments of the impact investing movement over the past decade and identified the challenges it continues to face in a recent podcast for the second season of the Knowledge@Wharton series, From Backstreet to Wall Street. This series focuses on women, innovators and entrepreneurs who are building sustainable peace. (Listen to the podcast above; you can find the rest of the series here.)

At its core, “the simple idea of impact investing is that our for-profit investments are both an economically effective and a morally appropriate way to address a social problem,” said Bugg-Levine. As a concept, impact investing existed well before the term was coined. He noted that American founding father Benjamin Franklin had set up a fund to provide loans to small business owners “so they could buy guild licenses and start their small businesses in other countries,” and that the Rothschild family in the U.K. in the 19th century set up a revolving loan for housing.

“We have a very large financial services industry that is set up and built around an idea that is antithetical to impact investing.” –Antony Bugg-Levine

Impact investing has come a long way from those days. The current size of the global impact investing market is an estimated $502 billion, and is deployed by 1,340 organizations, according to the Global Impact Investing Network, a nonprofit seeking to remove barriers to social investments. “We have a lot to celebrate, but face a lot of questions still that we need to explore,” said Shahnaz.

Shahnaz said it’s time to reflect on how successful impact investing has been in achieving its original goals. It was borne out of the need for “a new set of values that respects people and planet, and even the poorest of the poor,” she added. “Impact investing is becoming more mainstream, and both large private equity funds and international NGOs are jumping into it.” Many look to impact investing as a way to address “some of the inequality and the turmoil” in the world, Shahnaz said.

In a way, impact investing has been inherent in how people use money whether they realize it or not. “Money is a construct. Humans came up with it. It was a way to organize our economy in our societies, but it’s not an end in itself. It really has always been a means to create the world that we want to live in,” Bugg-Levine said. With impact investing, “we’re returning to a core instinct that I do believe most humans have, which is that wealth and resources should be put to work not only to enrich the individuals that happen to own them at that time. Impact investing connects with an intuitive sense many people have.”

The Disconnect

Inequality in particular strikes a chord with Bugg-Levine, who was born and raised in South Africa and was “very motivated and inspired” by the anti-apartheid movement of the 1980s. In later years he worked briefly with the African National Congress and the South African Human Rights Commission, and carried his “investing for social good” maxim to other places he worked at, such as Columbia Business School and McKinsey, before finding his calling at the Rockefeller Foundation in 2007.

Bugg-Levine recalled that in earlier years he believed “investing was for making money … and the way to live a righteous life was through government or nonprofit work.” But it was in South Africa, after it was free of apartheid in the late 1990s, where he saw that “without economic power, people had a very hard time realizing the rights that they had won on paper through politics.”

That disconnect stayed with him when he joined the Rockefeller Foundation, where he found that notwithstanding its inspiring goals, money of a different magnitude was needed to solve global problems such as housing and sanitation for those who didn’t have them, or for helping “a billion farmers upgrade their productive capacity so they could live better lives, and so could their children.” The money needed for them far exceeded what was available in government and through philanthropy, he realized.

Yet, Bugg-Levine saw there was enough capital around. “It’s just sitting in the capital markets, almost entirely not paying attention to the power it has to unleash so many positive changes,” he said. That was his Eureka moment for impact investing as a way to bridge the funding gap, and to articulate his own mission statement: “We have an obligation and an opportunity through impact investing to play one small part in helping us and our world not just become one in which people enjoy better material resources, but really one in which we are able to spread the capacity and the opportunities of justice to all people.”

“We started off sort of boiling the ocean, and the ocean is now lukewarm, so maybe we are doing something right.” –Durreen Shahnaz

Shahnaz recalled getting all fired up after Bugg-Levine encouraged her to take the plunge into impact investing. She visualized IIX as “a social stock exchange … a beacon of that perfect financial system where everyone will have a voice.” Bringing on board the support systems to achieve that was not an easy journey, although she looked back on it with some satisfaction. “We started off sort of boiling the ocean, and the ocean is now lukewarm, so maybe we are doing something right.”

A Third Phase

The impact investing space has evolved over the past decade in distinct phases. The first phase saw “innovators who were focused and motivated by mission, and were developing small investment funds and products on the outside of the mainstream,” said Bugg-Levine. “They were lonely, but they were able to keep things going.” In the second phase, “mission-motivated people” moved into mainstream financial services institutions, where they were able “to start a little program or start a fund” designed around impact investing, he added.

“Now, we’re entering a third phase in which there’s enough momentum among the owners of wealth who want their fund managers and wealth advisors and institutional investors to provide them with impact investing products,” said Bugg-Levine. “Those institutions are engaging with [impact investing] not because they care about impact, but because they recognize it as the next major opportunity for marketing, increasing sales and customer relations. We now are in a phase in which industry is going to be led to scale by people who are responding to what they see as client interest, rather than a deep personal motivation.”

In that setting, Bugg-Levine emphasized that impact investing needs “to scale with integrity,” or that the businesses that do impact investing should not be driven solely by their profit motives.

Challenges Ahead

While much opportunity awaits the impact investing community, it also faces formidable challenges. “We have a very large financial services industry that is set up and built around an idea that is antithetical to impact investing,” said Bugg-Levine. He noted that obstacles exist in “the way financial services companies are set up, the way that regulation and law dictates what they can do, and the cultural norms associated with how we keep score with our investments.” For sure, numerous organizations including companies are investing to address social problems, but the untapped potential is huge, he said. “It is going to require us to overcome a set of systems that have been built over generations to realize that potential.”

More wealth has been created in the last few decades than in earlier times, but the gap has also widened between haves and have-nots, Shahnaz noted. Mindsets have been slow to change, she noted, especially in her home turf of Asia. “Over the last decade, it took us a while to even get people on board in terms of understanding what impact investing is and how they can be part of this ecosystem,” she said. “A lot of education needs to happen in terms of what impact investing is about and what it’s for.”

According to Bugg-Levine, “one of the biggest barriers is the disconnect between the urgency that communities who need social issues solved … versus the inertia within the mainstream financial services institutions.”

Bugg-Levine said he encountered that urgency in a poor neighborhood in the Bronx borough of New York, a few hours after he met with institutional investors. He talked of his meeting with “an incredibly inspiring entrepreneur” who is mobilizing a community response to help turn around the lives of young people at risk of going to jail. His organization is considering a $1 million loan to support the effort.

“The disconnect between the sense of comfort and complacency with investors who are committed to impact investing but frankly are living pretty comfortable lives, and the real sense of urgency in a community in the Bronx, crystallized for me the challenge we have,” said Bugg-Levine. Added Shahnaz: “The sense of urgency is extremely difficult to [bring home to] anyone on the investor side. If it doesn’t impact them directly, the sense of urgency for them is very far and very remote.”

Moreover, investors are averse to taking risks with impact investing, Shahnaz noted. She recalled her experience with IIX’s first Women’s Livelihood Bond three years ago which raised $8 million to help 385,000 women entrepreneurs in Southeast Asia. IIX had to enlist a banking partner because it didn’t have the license to float its bonds in the public market.

But the bank was not fully on board with IIX’s plans. “They came to us and said, ‘You know, this is just too risky. People don’t understand it. What’s this – women in the remote part? Just drop the women and call it a high-yield bond, and then maybe we can do something,’” Shahnaz recalled. She refused to drop the reference to “women” in the bond’s branding. The bank said it would agree to be part of the bond sale if somebody else stepped in to provide a first-loss guarantee. “I put in all my savings as the first-loss [guarantee],” she said.

“Without economic power, people had a very hard time realizing the rights that they had won on paper through politics.” –Antony Bugg-Levine

Drawing from that experience and others, Shahnaz said investment funds have to appreciate that impact investing comes with its own set of risks, and they have to match that with their investment appetite. Social investment bonds inherently carry risks, she added. “Those won’t come in a package, nicely wrapped, with a bow on top. These things are messy. These are supposed to be messy. They are supposed to be complicated, because you’re trying to solve very complex social issues and environmental issues.” IIX successfully completed its first Women’s Livelihood Bond issue, and is currently seeking to raise $100 million in the second edition of those bonds.

Untapped Potential

Bugg-Levine recalled Shahnaz telling him that she designed IIX “not just to create conduits between the capital markets and the people who can use that in productive ways,” but also to “impact the way the investing industry works.” The second of those two objectives holds the key to realizing the potential for impact investing.

“It’s not going to be enough to simply find the very narrow slivers of ways in which the capital markets, led by people operating with the way they currently organize their firms, find a few things that are investible on the terms that they recognize and are used to seeing, and move money into that,” said Bugg-Levine. “[However], it’s not good enough to have a financial services industry that works with the incentives and the structures the way it always has.” Innovation is required in the way they are structured and function in order to create a capital market that moves money into organizations working to alleviate social distress, he added.

Bugg-Levine saw the potential for innovation to address the combined effect of three distinct trends in the impact investing space. One is the urgency to address social issues. The second trend he spotted is “a real shift in interest in this kind of work – especially among younger people.” The third trend is made up of structural changes within the investment industry, where more of mainstream investments are being handled by algorithms. “Those three trends have some real disruptive potential,” he said.

Beyond all those, impact investors have to recognize that “we are not a substitute for political action and well-functioning governments,” Bugg-Levine said. “We are a complement, and in many ways only get to make a difference and make a return when we ally ourselves with progressive governments that are moving the way that society works. We can’t be functioning well in a society that’s organized around greed.”

Shahnaz hoped for a future “where you don’t have to even talk about impact investing, because it will be the most natural thing.”

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